Duncan’s Economic Blog

Currency wars redux or the birth of a new international monetary system?

Posted in Uncategorized by duncanseconomicblog on September 6, 2011

Remember the currency wars?

After a relatively peaceful 2011 – some yen intervention and by now traditional Chinese moaning aside – they seem to be flaring up again.

The appreciation of the Swiss Franc has been causing the Swiss National Bank (SNB) headaches for months and today they have shocked the markets by announcing a unilateral peg to the Euro.

As the Macro Man blog notes in perhaps the best bit of analysis so far: 

SNB just announced that they are the World’s issuer of currency and liquidity provider of last resort.

This is the boldest response we have seen from anyone during this crisis. They must have been watching Crocodile Dundee ..”That’s not an intervention…. THIS is an intervention”

SNB have handed monetary control of Switzerland to ECB

SNB have lost control of their balance sheet.

SNB may also lose control of their mandated responsibility towards price stability

Is pegging yourself to a currency that may split in two the wisest thing to do?

Is the act of pegging to euro to be read as a huge vote of confidence in it?

Swiss rates “should” converge with Europe if currencies are pegged.

BUT If you have the choice of buying CHF or EUR assuming that they are pegged, then on a “will it be there tomorrow” front you always buy CHF  

So  that means that interest rates CAN be different and will solely reflect Euro blow up risk plus SNB failure risk.

A rebirth of the currency wars matters for Britain.

The current consensus of independent economists (tables 1 & 4) is that net trade will contribute 100% of 2011 growth and 30% of 2012 growth. Anything which makes exporting more difficult will have a serious impact without a change of policy.

As I’ve noted myself, perhaps the best contributionBritain could make to resolve these fraught international issues is to establish a State Investment Bank.

The Swiss have shocked the markets with this unilateral move and there are questions as to if it will work – if the Eurocrisis worsens and risk aversions rises again then the SNB is going to have to intervene very heavily to prevent appreciation.  

But what if it does work? Could this possibly, 30 years after the end of Bretton Woods, be seen as the start of a new system of fixed exchange rates? Mervyn King has audibly pined for something similar in the past – it can’t be ruled out. This might not be the start of a new round of ‘currency war’ but the birth of a new international monetary system.

5 Responses

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  1. migeruet said, on September 6, 2011 at 2:27 pm

    It’s not a peg, it’s a one-sided bound on the value of the currency.

    The Swiss Central Bank can _always_ defend against a CHF revaluation which, let’s not forget, was entirely speculative or “flight-to-safety” and not based on the strength of the Swiss economy or its trade flows. The massive influx of hot money left the Swiss economy vulnerable to a currency collapse in the event of a massive outflow should the “flight to safety” subside.

    The SNB may use the opportunity to accumulate EUR reserves in an amount sufficient to hedge the EUR asset and liability exposure of its banking system, which might yet prove instrumental in preventing Switzerland from becoming “Reykjavik on the Alps” (refer to Willem Buiter’s writings on “small countries with large internationally active banking systems).

    The SNB’s balance sheet doesn’t matter. The SNB is not accumulating foreign currency liabilities with this move so its solvency is not at risk. A central bank is by definition solvent in its own currency.

    Reportedly the SNB is buying only French and German bonds. If the Euro breaks up, the German bonds will not lose value wrt. the CHF, and may even gain value. The French bonds… it’s a toss-up.

    Something the SNB have likely done today with a 9% FX move in minutes is bankrupt a number of leveraged FX speculators. They have not put their price stability mandate at risk. If and when there’s a risk of inflation, they can sell their accumulated EUR reserves to retire the CHF they printed today. As of today, the ECB is exporting its deflationary bias to Switzerland and a one-sided bound on the FX is the SNB’s best choice.

  2. jomiku said, on September 6, 2011 at 2:32 pm

    I’ve long read Macro Man’s blog.

    My comment: it’s an invitation to the markets to push into Swiss Francs. Buy now and the pressure of events will push the currency up later. You may have to ride out a few rough patches but SNB won’t actually surrender control of its balance sheet to a 1.2 peg.

  3. JakeS said, on September 6, 2011 at 3:26 pm

    SNB just announced that they are the World’s issuer of currency and liquidity provider of last resort.

    *shrug*

    That’s the point of having a central bank. If RoW wants to conduct its business in Swiss Francs, then there is no particular reason why the SNB should not avail itself of the opportunity to score some hard currency.

    SNB have handed monetary control of Switzerland to ECB

    In a word, no.

    Unrestricted open market purchases of €-Mark in order to defend the Swiss Franc against appreciation does not in any way, shape or form prejudice the Swiss CB’s ability to dictate the risk-free yield curve of Swiss Francs.

    The Swiss CB can always defend the Swiss Franc’s risk-free yield curve by offering to rediscount any eligible collateral at the policy rate and to pay a support rate on excess reserves. Nothing about buying €-Mark in the open market compromises the ability of Swiss banks to arbitrage against the Swiss CB’s Franc yield curve, and nothing about fixing the yield curve compromises the SNB’s ability to buy as many €-Mark in the open market as the open market is willing to sell at the quoted offer.

    Attempting to defend the Franc against depreciation would slave the Swiss rediscount rate to the ECBuBa rediscount rate, because attempting to defend your currency against depreciation entirely through open market operations is an exercise in futility. But that’s not what the Swiss CB is trying to do. (And wisely so, since attempting to defend your exchange rate against depreciation by slaving your rediscount rate is also an exercise in futility, since excessive interest rates will, eventually, disrupt your economy’s ability to honour the implicit hard currency obligations created by the attempt to defend your exchange rate against depreciation.)

    SNB have lost control of their balance sheet.

    *shrug* A central bank, assuming that it does its job and acts as market maker of last resort and liquidity provider of first and last resort, never has all that much control of the asset side of its balance sheet. And this intervention does nothing to compromise its absolute control of the liability side of its balance sheet.

    SNB may also lose control of their mandated responsibility towards price stability

    Quantity fallacy of inflation.

    The only way that this intervention could create inflation is if the hot money flowing in suddenly develops an appreciation for Swiss engineering and starts buying real stuff instead of central bank reserves. It is theoretically possible that the hot money decides to inflate an asset bubble instead, but if the Swiss financial regulator is on the ball it should be possible to cut such an attempt off at the knees.

    Is pegging yourself to a currency that may split in two the wisest thing to do?

    It’s not a peg. The Swiss CB has made no commitment to defend the CHZ from depreciation.

    Is the act of pegging to euro to be read as a huge vote of confidence in it?

    It’s still not a peg. And no, this action is an exercise in accumulating enough ForEx reserves to make sure that the hot money currently flowing into Switzerland can flow out again in an orderly manner that does not invite a Soros attack.

    Swiss rates “should” converge with Europe if currencies are pegged.

    But they aren’t, so they shouldn’t. Specifically, since the intervention is one-sided the arbitrage condition at the core of that conclusion breaks down.

    My comment: it’s an invitation to the markets to push into Swiss Francs. Buy now and the pressure of events will push the currency up later. You may have to ride out a few rough patches but SNB won’t actually surrender control of its balance sheet to a 1.2 peg.

    Don’t bet your pension on that.

    This is all driven by hot money exiting the €-Mark, not any newfound enthusiasm for Swiss craftsmanship. Which means that the Swiss CB does not have to enforce this exchange rate floor indefinitely – it only has to enforce it until the hot money starts getting margin calls. That’s a game of chicken where the SNB is driving a tank and the hot money is driving a Pinto.

    – Jake

    • Gareth said, on September 7, 2011 at 12:43 pm

      “That’s a game of chicken where the SNB is driving a tank and the hot money is driving a Pinto”

      That’s just glorious, Jake. Best comment on the SNB action I’ve read yet.

      I’m dumbfounded why anybody would confuse a minimum fx level target with a “peg”; poor show to guilty parties. This is QE on a grand and exciting scale, exactly the kind of shock and awe which other CBs should be replicating. Are you watching, Ben, Merv?

      And next week, Israel invades Syria. Duncan immediately blogs:

      “perhaps the best contribution Britain could make to resolve these fraught international issues is to establish a State Investment Bank”

      (Sorry, sorry, I couldn’t resist that)

  4. yorksranter said, on September 6, 2011 at 4:09 pm

    They’re basically going Chinese. One-way intervention, sterilised. Will they roll the accumulating €s into a sovereign wealth fund?


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